VAT on directors’ fees: Back to square one?

Initially published on AGEFI

Much awaited by the Luxembourg market, the Court of Justice of the European Union (“CJEU” or the “Court”) released its decision on 21 December 2023 regarding the VAT treatment applicable to directors’ fees (C-288/22, TP v. Administration de l’Enregistrement et des Domaines et de la TVA). The CJEU took a two-step approach to conclude whether the activity of the director in the case at hand was falling within the scope of VAT. First, the Court looked at the existence of an economic activity and secondly, the Court analysed whether this activity was performed independently.

In the first place, the CJEU indicated that an economic activity should be recognised if the director receives a predictable compensation for his services with a certain degree of permanence (this would be the case despite the fact that the directorship mandate could be revoked at any time and with no motivation or even when the directors’ fees would only be paid under the condition that the company was making a profit).

Secondly, the CJEU listed several criteria to determine if the director was effectively acting independently. This question appears to be more complex than what we would have expected and the following points were raised by the Court:

• Is there a complete absence of any employer-employee relationship?
• Is the director acting on his own account and under his own responsibility?
• Is the director free to arrange how he performs his work?
• Is the director receiving the emoluments which make up his income?
• Does he bear the economic risk associated with carrying out those activities?

Although most of the above criteria were met, in essence, the decisive factor to consider was whether the director personally bore an economic risk as a result of the mandate he received (i.e. he personally bears a risk of loss and profit).

The CJEU considered that the director was not acting independently notably due to the fact that it is the company itself that will have to confront the negative consequences of the decisions adopted by the board of directors and that will accordingly bear the economic risk resulting from the activity of the members of that board. This is especially true from a Luxembourg company law perspective as the members of a board of directors do not assume any personal obligations concerning the debts of a public limited company.

In essence, the CJEU ruled that a natural person acting as a director of a commercial company is not a taxable person with the consequence that his/her remuneration should not be subject to VAT.

The outcome of this judgment is consistent with a previous judgment of the Court in the “IO” case (C-240/18) which dealt with the activity as a member of the Supervisory Board of a foundation.

Now the case will be referred back to the Luxembourg district court which initially referred the case for a preliminary ruling to the CJEU and it remains to be seen whether the local decision will give further clarity as to its practical interpretation.

The initial position from the Luxembourg VAT authorities since 2016^[1] was to consider that independent directors were taxable persons and that their remuneration was therefore subject to VAT (unless the small undertaking regime with turnover of less than €35,000 or the fund management exemption foreseen by article 44.1.d were applicable). The wait for a reaction from the Luxembourg VAT authorities was not long as a new circular letter n°781-1 was published on 22 December 2023 to suspend with immediate effect the application of their previous circular letter. As such, for the time being and until further notice it seems that VAT is no longer applicable on directors’ fees in Luxembourg.

Although everyone hoped that this decision would be the end of the story, this is unfortunately not the case.

Further communication announced by the Luxembourg VAT authorities

The Luxembourg VAT authorities already indicated that a new circular letter will be issued as soon as the Luxembourg district court will release its decision. The timing for the release of this decision is however unknown for now. The ideal situation would be to limit past adjustments to voluntary corrections and notably to companies having a partial recovery right which self-assessed Luxembourg VAT on directors’ fees paid to non-Luxembourg-based directors.

In their first communication dated 22 December 2023, the Luxembourg VAT authorities initially implied that a mandatory adjustment would be expected for the periods within the statute of limitation period (normally until 2019). However in their second communication dated 15 January 2024, the Luxembourg VAT authorities indicated that directors who want to regularise the situation but that do not want to wait until the release of the new circular, should:

• issue credit notes for the initial invoices issued with VAT;
• refund the unduly collected VAT to the companies where they sit at the board of directors; and
• file a request to obtain a refund of the VAT remitted to the VAT authorities less the VAT that was recovered on some of their costs, if any.

Besides the above actions, Luxembourg-based directors would also potentially be required to file corrective VAT returns and potentially a VAT de-registration. Exceptionally, the authorities indicated that they would waive the prescription for 2018 to allow a regularisation for that period.

Companies which paid directors’ fees with VAT (either charged locally or under the reverse charge mechanism) will also have to adjust their own situation. Hopefully directors established in other EU Member States would not be asked to cancel the reporting made in their European Sales listings if any but the Luxembourg VAT authorities remained silent in that respect for now.

The Luxembourg VAT authorities announced they will put in place a specific online procedure via myGuichet (referred to as a “non-bureaucratic” regularisation for directors). This possibility might lighten the overall process although this could remain complex to handle in practice for all the stakeholders involved (i.e. directors, companies but also the Luxembourg VAT authorities). If the regularisation is confirmed to be mandatory, it would also lead to a breach of the principle of legal certainty^[1] as everyone acted in accordance with the circular letter issued by the Luxembourg VAT authorities many years ago. This all remains to be seen but we will anxiously await their final say.

Are all directors in the same situation?

Based on the practice in Luxembourg, the circumstances of the case dealt by the CJEU should be quite common for a majority of directors of public limited companies and VAT would in principle no longer be applicable.

However, the CJEU ruled on the specific circumstances of the case at hand and excluded several situations from its analysis and notably the ones where a director:

• would have a casting vote within the boards of the public limited companies of which he was a member;
• would assume the representation or daily management of the business of these companies; and/or
• was part of a management committee in these companies.

Situations could occur where directors may be in charge of daily operations of companies and would be potentially held liable personally for the companies debts. Hence these cases would need to be dealt with separately and hopefully the Luxembourg VAT authorities will take a clear position in their coming circular in that respect.

Additionally, the CJEU remained silent as to whether its reasoning would also apply to a director who acts through his/her personal company or more broadly a company employing the director which directly invoices the company for which the director is appointed (regarding only the provision of a director and not the provision of a more global service). The case of companies appointed as corporate directors was also not dealt with by the Court in this specific case.

Looking at the decision from the CJEU, it seems that its reasoning would similarly apply whether the director of the board is an individual or a legal person although this remains unclear. Reaching another conclusion could likely lead to unfair competition as directors’ fees would be outside the scope of VAT in one case and subject to 17% VAT in another. The first communication from the Luxembourg VAT authorities also seems to imply that legal persons providing directorship services would be impacted by the recent Court ruling as they stated that the new circular letter will also “address companies for which VAT was charged by their directors and that will have to adjust their input VAT recovery to the new legal situation, subject to the applicable sanctions as foreseen by the law”. Interestingly, in Belgium, since 1 June 2016, legal persons appointed as directors of the board are VAT taxable persons. This was implemented in Belgium based on the European Commission’s opinion on the topic. 

^[1] Decision from the Luxembourg District Court, 07/12/2016, n° 168940

Conclusion

To some extent a certain level of uncertainty remains and we will now await the decision from the Luxembourg District Court as well as the new circular from the Luxembourg VAT authorities to end this story once and for all.

Directors should already reassess their situations in the light of the decision from the CJEU and anticipate the potential actions to be taken if mandatory adjustments are required by the Luxembourg VAT authorities. More to come, so stay tuned!